AMERICANS fool themselves if they ignore the
parallels between Europe's problems and their own. It's reassuring to think
them separate, and the fixation on the euro - Europe's common currency -
buttresses that mindset. But Europe's turmoil is more than a currency crisis
and was inevitable, in some form, even if the euro had never been created. It's
ultimately a crisis of the welfare state, which has grown too large to be
easily supported economically. People can't live with it - and can't live
without it. The American predicament is little different.

Government expansion was one of the 20th century's
great transformations. Wealthy nations adopted programmes for education,
healthcare, unemployment insurance, old-age assistance, public housing and
income redistribution. 'Public spending for these activities had been almost
nonexistent at the beginning of the 20th century,' writes economist Vito Tanzi
in his book Government versus Markets. The numbers are astonishing. In 1870,
all government spending was 7.3 per cent of national income in the United
States, 9.4 per cent in Britain, 10 per cent in Germany and 12.6 per cent in
France. By 2007, the figures were 36.6 per cent for the United States, 44.6 per
cent for Britain, 43.9 per cent for Germany and 52.6 per cent for France.
Military costs once dominated budgets; now, social spending does.

In the 1880s, German Chancellor Bismarck created
health, old-age and accident insurance: landmarks regarded as originating the
welfare state. The Great Depression discredited capitalism, and after World War
II, communists and socialists enjoyed strong support in part because they 'had
formed the backbone of wartime resistance movements', writes Barry Eichengreen
in The European Economy Since 1945. To flourish, the welfare state requires
favourable economics and demographics: rapid economic growth to pay for social
benefits; and young populations to support the old. Both economics and
demographics have moved adversely.

The great expansion of Europe's welfare states
started in the 1950s and 1960s, when annual economic growth for its rich
nations averaged 4.5 per cent compared with a historical rate since 1820 of 2.1
per cent, notes Eichengreen. This sort of growth, it was assumed, would
continue indefinitely. Not so. From 1973 to 2000, growth settled back to 2.1
per cent. More recently, it's been lower.

Demographics shifted, too. In 2000, Italy's
65-and-over population was already 18 per cent of the total; in 2010, it was 21
per cent, and the projection for 2050 is 34 per cent. Figures for the European
Union's 27 countries are 16 per cent, 18 per cent and 29 per cent.

Until the financial crisis, the welfare state
existed in a shaky equilibrium with sluggish economic growth. The crisis
destroyed that equilibrium. Economic growth slowed. Debt - already high - rose.
Government bonds once considered ultra-safe became risky.

Switch to the United States. Broadly speaking, the
story is similar. The great expansion of America's welfare state (though we
avoid that term) occurred in the 1960s and 1970s with the creation of Medicare,
Medicaid and food stamps. In 1960, 26 per cent of federal spending represented
payments for individuals; in 2010, the figure was 66 per cent. Economic growth
in the 1950s and 1960s averaged about 4 per cent; from 2000 to 2007, the
average was 2.4 per cent. Our elderly population was 13 per cent in 2010; the
2050 estimate is 20 per cent. What separates the US and Europe is that (so far)
we haven't suffered a backlash from bond markets. Despite high and rising US government
debt, Treasury securities still fetch low interest rates, about 2 per cent on
10-year bonds. Will that last? It's true that cutting spending too quickly
might threaten a fragile economic recovery. But President Obama and Congress
can't be accused of making this mistake. They do little and excel at blaming
each other.

The modern welfare state has reached a historic
reckoning. As a political institution, it hasn't adapted to change. Politics
and economics are at loggerheads. Vast populations in Europe and America expect
promised benefits and, understandably, resent any hint that they will be cut.
Elected politicians respond accordingly. But the resulting inertia poses an
economic threat, one already realised in Europe. As deficits or taxes rise, the
risk is that economic instability will increase, growth will decline, or both.
Paying promised benefits becomes harder. Or austerity becomes unavoidable.

The
paradox is that the welfare state, designed to improve security and dampen
social conflict, now looms as an engine for insecurity, conflict and
disappointment. Facing the hard questions of finding a sustainable balance
between individual protections and better economic growth, the Europeans have
spent years dawdling. The parallel with our situation is all too obvious.